Disclaimer: I am not an attorney and cannot give legal advice. This series is from a supply chain practitioner’s perspective on negotiating contracts and is simply offering my perspective on common contract clauses. Seek professional legal advice for your own contracts.
In our continuing series on contract clauses from a supply chain perspective, last week we talked about forecasting and delivery. This week we will talk about nonconformance, inspection, and payment terms. My side note this week is also about contract philosophies, which is something to ask yourself with any contract: what is the philosophy for this contract and how does it impact how I negotiate it?
Good news: we’re about halfway through my template! I know it’s a bit of a slog, but hopefully the deep dive helps truly understand how contracts work and helps you decide where to focus in your own negotiations. This week’s topic is far less exciting, but does contain one of the most frequently changed clauses: payment terms.
The example contract clauses and discussions of them below are separated by horizontal dividers to help you switch between them.
Nonconformance Clause
9. NON-CONFORMANCE
Seller shall notify Buyer immediately in the event Seller becomes aware that it may not be able to deliver Product(s) that conform to Sections 5 (Compliance with Laws) or 10 (Inspection and Rejection) hereof and shall provide a written plan of action to correct any non-conformance. If Buyer, in its sole discretion, determines that Seller will be unable to produce or deliver conforming Products within a reasonable time period, then Buyer may terminate any outstanding Purchase Order for such Products or terminate this Agreement for cause. Notwithstanding any notice that Seller may give to Buyer regarding non-conforming Product(s), Seller shall continue to comply with its obligations under this Agreement and the Purchase Order, including without limitation, its obligations for the manufacture and timely delivery of the Product(s), and all terms and conditions of warranty, delivery, timeliness, and indemnification shall remain in full force and effect.
The nonconformance clause is one of the ways a buyer can terminate the contract for cause. There is a whole clause on termination, its terms, and its parameters later (clause 20 in this example contract template), but this particular clause is trying to emphasize that law compliance and inspection really are important clauses and are grounds for termination. Is this clause truly necessary to be separate from the main termination clause? Probably not. It’s here more as a stick-waving clause to be threatening, and could be consolidated with that later clause if desired. If a supplier strikes it, I would generally let them and make sure the references to these same clauses (law compliance and inspection) are in the main termination clause.
Side Note: I have seen several different philosophies toward contracts in general. This particular template’s philosophy is to have a few key terms intentionally repeated in hopes a supplier does not redline all of the clauses referring to a particular point. Another philosophy is to keep a contract as short as possible, removing any clauses not relevant to a relationship. I see this most often as a way to template purchase order terms, which are intended to be fairly minimal. Another philosophy is to ensure a very complete contract, which might be more than 40 pages of single spaced 11 point font. The last philosophy I’ve seen is where the template is written extremely heavily in the author’s favor (either buyer or seller), but with a lot of backup clauses available to swap out for any objections. This one is common for IT software, where the supplier typically insists on starting with their “paper” or template. There are probably additional philosophies, and of course some of these can be combined, but these are the ones I have encountered most often.
Inspection Clause
10. INSPECTION AND REJECTION
Buyer may inspect and reject all non-conforming Product(s) within a reasonable time period after Delivery and without regard to whether payment has been made for such Product. Buyer may but is under no obligation to conduct any inspection of any Product prior to assembly and/or resale to its customers and all warranties of Seller shall survive inspection, installation, assembly, acceptance and payment by Buyer. Seller will participate in such analysis and inspection in accordance with Buyer’s procedures. Buyer, at its option, may inspect all or a representative sampling of Product items and may reject all or any portion of the Products if it determines the Products are nonconforming or defective. Buyer may choose, in its sole discretion, at Seller’s risk and expense, either to hold non-conforming Products pending receipt of Seller’s Return Material Authorization (hereinafter, “RMA”) number and instructions which shall be sent to Buyer within three (3) business days from notification by Buyer, or to ship the non-conforming Product to Seller’s address shown on the Purchase Order. If a Product is returned, Seller will have fourteen (14) calendar days, which includes transit time, to dispute the rejected Product or contact Buyer’s Quality Department to request additional time for evaluation. If Seller agrees with the rejection, Seller will supply Buyer with a credit note for the value of the Product at purchase price. If Seller disagrees with the rejection, Seller must contact Buyer’s Quality Department for disposition. If no contact is made by Seller after thirty (30) calendar days, Buyer has the right to declare a corresponding credit and set off. If a Product is determined by Buyer to be non-conforming due to Seller’s fault or negligence, Seller shall promptly, upon request, reimburse Buyer for all reasonable related costs, losses, penalties and expenses incurred therewith.
The inspection clause is about the process and timing of inspections. While this clause is generally thought to apply to materials, it can also apply to services such as software configurations or contracted work products. The most common supplier edits to this clause include:
- Moving the expense of shipping nonconforming product back onto the buyer instead of allowing the buyer to ship back using any method they like and at seller’s expense. Depending on where the seller is located, I will sometimes allow this. Or I will add language about using the seller’s UPS or FedEx account and not expediting shipment, allowing them some level of control and comfort.
- Changing timeframes, such as to remove transit time from the seller’s response time or simply give more time to respond to a reported nonconforming product. Within reason, I usually allow changes to these timeframes. The important thing is that timeframes exist, not that the timeframes are short.
- Editing the “automatic” nature of the RMA credit. Unless a supplier has a very robust and well-organized RMA process, I usually fight this one. Seeking a credit for a nonconforming product can be a long and drawn-out process, and can even end in legal action. It’s better to have a clear process by which you can get your credit and move on.
- Removing the section on reimbursing buyer for all related costs. This one tends to only be edited by very meticulous suppliers, and I will fight for it depending on how the other clauses went and how much I anticipate extra work in dealing with supplier RMAs. I’m more likely to fight for this clause with international suppliers, simply due to the additional friction with overseas suppliers.
Payment Clause
11. PAYMENT
Buyer shall pay Seller net sixty (60) days after the latter of (i) the date a correct invoice is received at Buyer’s “bill to” address, or (ii) receipt of the Product, except for any amounts disputed by Buyer in good faith. Seller shall extend appropriate credit limits to Buyer that accommodates said payment terms regardless of current volume requirements. Buyer encourages Seller to use Automatic Clearing House (hereinafter, “ACH”) for receipt of all payments by Buyer. All invoices must bear the applicable Purchase Order number, packing slip number, Purchase Order item number, Buyer’s part number and quantity. There should only be one Purchase Order per invoice and invoices should be sent to [Company AP Address]. Buyer shall be entitled at any time to set off any and all amounts owing to it by Seller against amounts payable by Buyer to Seller.
Payment terms are probably the most edited clause in most contracts, unless the default payment terms are “immediate”. Suppliers almost always want to be paid sooner, and companies want to delay payment as long as possible. I will write an article at some point in the future diving into payment terms, but for now this template uses a default payment term of 60 days. The note on timing of payment terms is important to clearly outline when the clock starts on the term. It is common for suppliers to invoice when they ship product, regardless of the Incoterms or shipping timeframe. While this is understandable and acceptable, it requires this clause’s note about payment terms starting from when the buyer receives products. Especially when products take 4-6 weeks to cross oceans, with a 30 or 45 day term it is possible the invoice can be due before products can be safely received or inspected.
This clause also outlines the necessary components on an invoice. In this case there is not a requirement for a detailed breakdown of invoice charges, but that can be a very good addition to the clause. Requiring a detailed breakdown has the most value when your company has a good ability to use that breakdown data, is having trouble with suppliers creating very opaque invoices, and/or when you have a robust process for checking invoices against the contract. That wraps up this week’s deep dive into contracts, next week we will talk about product discontinuation or changes and buyer’s property, such as tooling. If you’d like to talk to me about your company’s contract clauses, schedule a time to chat.